The Fed hiked interest rates by another 25 points and retained their measured pace language. As always the markets reacted with extreme volatility on the announcement with strong moves in both directions. Elsewhere there were conflicting signs once again on the health of the economy but nobody was listening.

Dow Chart - Daily

Nasdaq Chart - Daily

Before the Fed announcement we saw data about employment in the Challenger Layoff Report. The report said layoffs fell to 57,871 in April from 86,396 in May. This was a very sharp drop and the lowest level since November 2000. The layoffs have averaged over 100,000 for the last six months. Needless to say this drop was a real surprise. This could be an indicator of the actual nonfarm payroll report due out Friday. However, it does not guarantee a pickup in hiring, just a reduction in layoffs. In another component of the Challenger report they did survey hiring intentions. Those planning to hire were up +21% over the March levels. Since the Fed gets an advance look at the non-farm payrolls and they raised rates it could mean the coming jobs numbers will not be weaker than expected.

March Factory Orders rose +0.1% and was much stronger than the expected -1.5% drop. This compares to a drop of -0.5% in February. Durable goods were revised up to only a -2.3% decline for the prior month. Nondurable goods were up +2.6% to offset the other declines. Overall this was a neutral report that suggests the economy is still stuck in the soft patch. Year over year total orders are still up +4.2% with nondurable orders up +10.4% mostly on gains made in Q4.

The April Risk of Recession Index rose +4% to 22% from 18% in March. This was the sharpest move higher since June-2004. This represents a mild level of risk but the sharp jump could be an indicator that higher risk lays ahead. Nearly all the components weakened and that includes the drops in consumer confidence and sentiment, hours worked and the drop in the stock market. The flattening yield curve is also a warning of trouble ahead.

The big news for the day was of course the FOMC meeting and rate announcement. The Fed hiked rates by +25 basis points to 3.0%. They also kept the "measured pace" language despite seeing some weakness in the economy. The Fed acknowledged that spending had slowed as a result of higher energy prices. The markets reacted strongly to the inflation statement, "pressures on inflation have picked up in recent months and pricing power is more evident." They removed the preface to that sentence that said "longer term inflation remain well contained." If you read between the lines on this announcement it shows the Fed is becoming more concerned about inflation and fear it may not be as contained as originally thought. This shook the markets and all the indexes traded sharply lower. Just before 4:PM the Fed issued a correction to the statement saying the "Longer-term inflation expectations remain well contained." They actually printed it in bold on the revised statement. This prompted shorts to cover and lifted the indexes back into positive territory.

The Fed repeated the claim that its current policy is still accommodative which means there are still more hikes ahead. After the meeting the Fed funds futures were showing hikes at June, August and September but November is still too close too call. They also took out the phrase that energy prices were NOT flowing through to core inflation. They removed that statement and said pricing power is more evident. This suggests the Fed is watching the inflation gauge rise and becoming more concerned as everything related to energy becomes more expensive. The sentiment that the Fed could take a pass in June was completely erased and the end of year target is still 4%. Several former Fed members interviewed on Tuesday said Greenspan is targeting 4.5% for 2006 as neutral territory. The Fed also said labor market conditions appear to be improving gradually. It will be interesting to see the Jobs numbers on Friday to see what prompted that statement. Does "gradually" mean that jobs are going to be positive but weak as we saw in March?

With nearly two months until the Fed meets again on June 28th the markets are free to wander on speculation about their next move. We will see two months of economic data and a lot can happen in that period.

The April auto sales came in at 17.5 million units and well over the 16.8 million in March. The local automakers did not fare well and were again outdone by the Asian trio. GM sales fell -7%, Ford -5.2% and DCX -5.2%. Honda rose +13%, Toyota +21% and Nissan +27%. The Asian automakers gained +4% of market share in just the last month and accounted for 29.3% of all vehicles sold. This is an all time high and was done with higher incentives and strong sales of hybrids. The bright side of the report was a lack of production cutback announcements from Ford and GM. Several analysts had been expecting a new round of cuts. This may mean sales are picking up for the American models. With oil prices weakening the sales of SUVs have picked up slightly and a new round of higher incentives are probably planned for the summer selling season.

In stock news Tyco posted earnings inline with estimates but warned that the higher cost of commodities and steel would lower earnings for the rest of 2005. Tyco is paying off debt at a rapid pace and trying to settle with the SEC over complaints stemming from the Kozlowski era. They are also considering selling their plastics and adhesives business as they streamline their business model. The CEO did stress the strong balance sheet and said Tyco is now strong enough to buy new businesses and healthcare was on the top of their list. Now if he had given us a couple names we could have made some money on that comment.
TYC was knocked for a -7% loss to $27.50 and a new 52-week low but it recovered to $28.60 by the close. This is a strong support level and a decent entry point if you have a long-term view. Resistance highs are back in the $36 range.

ERTS posted earnings inline with lowered estimates but said future quarters will likely fall far short of their prior forecast. They posted earnings of +9 cents compared to +25 cents for the same period last year. For the current quarter they now expect to lose -22 to -28 cents. Analysts were expecting a profit of +4 cents. ERTS dropped -$4 to $48.60 in after hours trading.

Crude Oil Chart - Daily

Oil prices have been very volatile of late and dropped back to close under $50 once again at $49.50. Traders fear another inventory build when numbers are reported on Wednesday. This is still related to the normal spring demand slump and I would still recommend adding to oil positions under $50. Boone Pickens was on TV yesterday claiming Saudi Arabia production has peaked and their claims of plans to invest $50 billion to increase it by 2009 will be too late to head off the decline. Even Jim Jubak has gotten on the Peak Oil bandwagon with a clear description of the problem at this link: http://moneycentral.msn.com/content/P113996.asp

The markets traded sideways on very little volume until the Fed announcement. It was one of the lowest volatility periods ahead of an announcement that I have seen in recent years. The Dow stabilized just below resistance at 10265 and then slowly bled points into the announcement. When the first press release hit the airwaves we saw the normal post announcement volatility with wide swings in both directions. As the TV commentators pointed out that the key "inflation contained" phrase had been removed from the statement the indexes imploded. They had declined to their support levels, around 10200 on the Dow and appeared ready to take a long dive. When the Fed took the unprecedented step of correcting their statement the shorts were squeezed once again. Suddenly the Fed went from concerned about inflation to unconcerned and the markets celebrated. A buy program 5 min before the bell squeezed the shorts even more and the Dow closed +50 points off its lows at 10256. The Dow still has strong resistance at 10265 but we are slowly chipping away at that level. None of the recent declines have held with dip buyers appearing every time we see the Dow under 10100. I believe we have been fighting the negative trend for so long that excessive pessimism may have taken hold and a short-term rally could appear. When the bears can't press their advantage to the downside it encourages the dip buyers.

The Nasdaq pattern is slightly weaker than the Dow with a close right in the middle of its recent range at 1934. Short-term overhead resistance remains 1960 with support at 1900. The SOX was no help but at least it was not a drag either with another close at 385. This has turned into a goal line stand for the SOX. The S&P, like the Dow, also closed at the high end of its recent range at 1161. With resistance at 1165 it is either poised for a breakout OR another trip back to support at 1140. We have seen five round trips from top to bottom and the close right at the top is a fat pitch waiting to be hit.

SPX Chart - 30 min

The only major economic report left for the week is the Jobs Report on Friday. The current estimate is +175,000 jobs and nobody is going out on a limb with wild estimates. A lower number could be market friendly in hopes of a slower Fed but I am beginning to believe that no amount of weakness is going to slow the Fed from its appointed task. A higher number could help convince investors the soft patch is ending and improve consumer confidence. For me this week I am watching the 1156 level on the S&P. This is the convergence of the 100/130 exponential averages on the 30 min chart and this level was support twice this week. I would be cautious about any longs over 1165 but I would get short under 1156. With earnings mostly over, the Fed behind us and summer coming fast, the next test of 1140 may not hold. Volume is going to begin fading but the bulls are trying to muster strength for one more breakout attempt for that greener pasture above. If they manage to hold any break over 1165 for more than a day it could attract some idle sideline cash. While I am still thinking we will see 9800 before long there is enough sentiment building that my short term bias is neutral over 1156.
I would continue to remain cautious and definitely, enter passively and exit aggressively.

New Plays

New Option Plays

by OI Staff

Call Options Plays

Put Options Plays

LLY

STRA

New Calls

Eli Lilly - LLY - close: 59.75 change: +0.84 stop: 57.49

Company Description:Lilly, a leading innovation-driven corporation is developing a growing portfolio of best-in-class pharmaceutical products by applying the latest research from its own worldwide laboratories and from collaborations with eminent scientific organizations. Headquartered in Indianapolis, Ind., Lilly provides answers -- through medicines and information -- for some of the world's most urgent medical needs. (source: company press release)

Why We Like It:We have had our eye on LLY as a bullish candidate for several days now, ever since the stock broke out above the $57-58 level and challenged its technical resistance at the 200-dma and the $60 mark. Not only is LLY trading above its previous five-month trading range but the stock's recent consolidation is suggesting a bullish breakout over the $60.00 level is imminent. The stock's Point & Figure chart also shows a bullish buy signal that currently points to a $74 target. While we are still cautiously bearish on the market in general the DRG drug index has completely ignored the market's recent weakness. Instead the DRG drug index is breaking out to new relative highs. The combined bullish picture with LLY set against a bullish DRG background looks like a tempting play for traders looking for call candidates. Besides if the market does turn lower the drug stocks are traditionally seen as "safe havens". Now that's never a guarantee but over time the drug-related issues can out perform the market when the market is slipping. Our strategy here is to use a TRIGGER to open the play. Our entry point will be $60.15. Our initial target will be the $65.00 region. Our time frame is six-to-eight weeks.

Suggested Options:We are suggesting the July calls although Junes are available.

New Puts

Strayer Education - STRA - cls: 103.41 chg: -5.25 stop: 107.25

Company Description:Strayer Education, Inc. is an education services holding company that owns Strayer University and certain other assets. Strayer's mission is to make higher education achievable and convenient for working adults in today's economy. Strayer University is a proprietary institution of higher learning that offers undergraduate and graduate degree programs in business administration, accounting, information technology, education, and public administration to more than 23,000 working adult students at 32 campuses in 8 states in the eastern United States and worldwide via the Internet through Strayer University Online. Strayer University is committed to providing an education that prepares working adult students for advancement in their careers and professional lives. Founded in 1892, Strayer University is accredited by the Middle States Commission on Higher Education. (source: company press release)

Why We Like It:This should be exciting. Normally we always suggest that readers never hold over an earnings report. There are too many unknown and unforeseen variables that can ruin an option play. We're not breaking that rule here with STRA but rarely have we ever played a stock so soon after its report. STRA is expected to report earnings BEFORE the market's opening bell tomorrow. That's important. We do not want to hold a position over the report. You may want to verify that the company has reported by checking the news first. Wall Street is expecting STRA to report earnings of 93 cents a share. Given the three-week down trend and today's 4.8 percent decline on above average volume there doesn't appear to be much confidence in STRA's report tomorrow. Even if they do beat the numbers investors might not trust it. Another education stock, CECO report today, beat the numbers, raised guidance and still the stock sold off. We're drawn to STRA because the stock has broken below its supporting trendline dating back to the August 2004 low. Currently STRA does have price support near $102.00-102.50. If STRA breaks down below this level it will reverse its P&F chart from a buy signal into a sell signal. Our plan is as follows. First, make sure STRA has reported before the bell. Second, if they beat earnings readers may want to consider taking a step back and merely wait a day to see how investors respond. Third, we are suggesting a TRIGGER at $101.95 to open the play. However, if STRA gaps down below the $100.00 mark we do NOT want to open the play. We do realize that these guidelines probably make this play a bit more complicated but we want to try and catch the breakdown not chase it. If STRA trades below $101.95 (but not gap below $100) then the play will be opened and our target will be the $95.00-93.00 range. An alternative entry point would be to look for a bounce back toward the $107 region and then buy puts on a failed rally there. We're going to start the play with a stop loss above the 200-dma.

Suggested Options:We are suggesting the July puts. June strikes are available but they have very low open interest.

Shares of IVGN showed some volatility this morning with a drop to $72.76 before quickly surging higher. IVGN hit a high of $75.72, which was more than enough for our TRIGGER/entry point at $75.51. The play is now open. We did hear some slightly negative comments about IVGN from an analyst on CNBC today but shares did not react. The stock looks poised for more gains tomorrow. We are still buyers although more conservative traders may want to see a little more confirmation before buying calls. Remember we are suggesting caution on all our bullish plays since the markets are currently bouncing inside their intermediate down trend.

Put Updates

Adobe Systems - ADBE - close: 57.29 chg: +0.14 stop: 60.26

There was no follow through on yesterday's weakness as ADBE consolidated in a tight range above its 200-dma. Meanwhile there were additional comments out today echoing yesterday's analyst sentiment that MSFT was not an immediate concern as competition to ADBE. In other news Macromedia (MACR), which is being acquired by ADBE, reported earnings today that beat estimates by 2 cents. MACR also said they were restating results for the last six years.

There isn't much happening in shares of INFY lately and right now that's just fine with us. The stock remains under the $60.00 level of what should be round-number resistance and it remains under its simple 10-dma. Tomorrow could be an important day as both the NASDAQ and the GSO software index are nearing short-term resistance.

Shares of LEH continued to sink following Monday's decline. Fashionably late Merrill Lynch decided to lower their earnings estimates on the big brokers (GS, LEH, and MWD) following Monday's downgrades by UBS and MWD. We see no changes in our strategy. Our target is the $86-85 level.

MAR continues to sink and the stock is nearing our target in the $60.00-58.00 range. Readers can prepare to exit. Conservative players may want to exit early as the $60 level might act as short-term, round-number, psychological support. MAR is getting a bit short-term oversold and due for a bounce. Don't be surprised to see a bounce back to $62 or $63.

How fortunate! PCAR started the day with a minor gap down. Then about lunch time the stock crashed lower and broke down below minor support near $66.00. Volume was very heavy at almost four times the norm. The sudden weakness could be attributed to a downgrade by Prudential. PRU downgraded CMI, NAV and PCAR. PCAR was cut from an "equal weight" to an "under weight" (a.k.a. "sell"). PRU sees a possible slow down in the heavy-duty truck market next year. This is certainly a welcome development. PCAR did produce an oversold bounce this afternoon but we would look for a possible failed rally in the $66.00-67.00 region and use it as a new bearish entry point.

Dropped Calls

None

Dropped Puts

None

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